European leaders next week will sign off on another $172 billion bailout for Greece, one small step back from a disastrous debt default. When the deal is signed, brace yourself for a chorus of charges from President Obamas critics that his policies will make America the next Greece. These Chicken Littles are talking nonsense. They misunderstand Greeces real weaknesses and our genuine strengths, along with governments role in each. Moreover, they miss the issue in the Eurozone crisis that matters most to America the new bailout will not prevent a broader European financial crisis that could tip the United States back into recession.
By the critics primitive reasoning, Greece has large deficits and public debt, and so does America, so the two countries must be headed for the same fate. If that were true, most of the world would be headed for default, since most nations today have large deficits and public debts. The economic fact is, the grave problems facing not only Greece, but also Italy, Portugal, Spain and Ireland lie much more in their economies than in their national budgets.
Yes, Greeces deficits skyrocketed when the 20082009 financial crisis stalled out its economy as in most of the worlds countries. And yes, the public debt of Greece, and Italy too, was large already as a share of GDP, so the burden of financing the new debt came on top of the burden of regularly refinancing their existing debts. But even that doesnt explain much, since Spain and Irelands existing national debts were modest by world standards. At the same time, Japans public debt is larger than almost anyones as a share of GDP, and no one worries about a Japanese default.
The economic issue in sovereign debt defaults is not the size of a nations public debt, but its economys capacity to finance it. The problem that Greece faces followed closely by Italy, Portugal, and Spain is that its economy is relatively unproductive and uncompetitive. When its financing burden soared in the deep recession following the 2008 meltdown, its businesses and people found themselves financially strapped, and so unable to generate the additional savings to finance the new debt. And Greece cannot become more competitive and boost exports by depreciating its currency, because it no longer has a national currency to devalue. Along with Italy, Spain and the other countries facing debt peril, Greece uses the Euro and the Euro exchange rate is set by the larger, more productive economies of Germany and France. Nor can Greece spur new investment in its economy with easy monetary policies, since the European Central Bank controls that for Eurozone members.
So, it is not simply Greeces large deficits and government debt that raise the possibility of default. Rather, that prospect rests on what can be called a perfect storm in public and private finance. Yes, Greece has fast-rising public debt. But one of the key reasons is that the Greek economy hasnt been strong and productive enough to come out of a deep recession now four years old and running. Thats the main reason why Greeces national debt soared from 113 percent of GDP to 163 percent in the last three years, despite its recent austerity. Its also why Greek businesses and households cannot generate the additional savings to finance that new debt.
Greeces low productivity, on top of its continuing recession, also has discouraged foreign investors from buying its bonds. Once the risk of default took hold in the minds of those investors, they have demanded much higher interest payments on new Greek government bonds to offset that risk. Those higher interest rates only compound Greeces problems, since they greatly increase the burden of both financing the new deficits and refinancing the governments prior debts. To top off all of this, Germany has turned these grim conditions into an imminent crisis by insisting that Greece embrace harsh austerity, right now, to reduce its deficits. But as the International Monetary Fund has warned, additional austerity in an economy already in recession or just recovering from one will only expand deficits.
Whatever President Obamas economically-untutored critics may claim, Americas circumstances are different from Greeces in every respect. The U.S. recession ended in mid2009 thanks to stimulus from the Presidents program and the Fed. Savings by both American businesses (retained earnings) and households shot up, providing additional resources to help finance our rising deficits. Moreover, the U.S. economy is the most productive in the world, attracting hundreds of billions of dollars in foreign funds to help finance both our business investments as well as our deficits. And the lowest long-term interest rates in generations signal clearly that global investors are confident America will stabilize its national debt as a share of its GDP. The only time that the United States has ever flirted with default came not from the economy or deficits, but from the reckless behavior of conservative extremists last year who threatened to block the debt ceiling legislation. And for the record, the U.S. public national debt as a share of GDP is considerably less than half that of Greece.
Credible signs are now appearing that the U.S. expansion is finally accelerating. The greatest threat to that upturn is a Greek debt default which then spreads to Italy or Spain. Unfortunately, that threat is very real. The conundrum here is that the new Eurozone bailout of Greece is predicated on the Athens government implementing yet more austerity and thats a losing strategy. Additional austerity almost certainly will only increase Greeces deficit and debt, not tame them, requiring more bailouts in the future.
At the same time, much of the Greek public unequivocally opposes more austerity. Its hard to blame them. Greeces GDP has contracted 25 percent through the last four years of savage recession, and unemployment there is now over 20 percent. Moreover, wages have fallen at least 20 percent the Eurozones only answer to Greeces low productivity and non-competitiveness. Now, Germanys Angela Merkel is insisting they accept another large dose of austerity. They just might say no, at which point a genuine default probably cannot be avoided.
That leaves Merkel with a clear choice. She can finally accept that the European Central Bank must stand behind the sovereign credit of every Eurozone member, or pray that a Greek default wont spread to Italy or Spain and threaten the solvency of most large European banks. Our own banks would probably survive a new European banking crisis, but theres little doubt that this scenario would cost the U.S. economy. So, while America has little in common with Greece fiscally or economically, our own short-term fate may still rest in its hands.